Banking fraud and blockchain technology

Context:

• Recently, PNB found that the SWIFT system had been misused by junior-level branch officials, who had fraudulently issued letters of undertaking (LoUs) on behalf of some companies for availing buyer’s credit from overseas branches of Indian banks.

How did the Punjab National Bank (PNB) scam work?

• Diamond merchant Nirav Modi has been accused of siphoning off funds worth about Rs. 11,500 crore from the public sector bank, PNB.
• A key element of the scam is the Society for Worldwide Interbank Financial Telecommunication (SWIFT), a messaging network that connects banks and other financial institutions across the world.
• Among other things, a bank that is part of SWIFT can use the system to convey credit instruments called letters of undertaking (LoUs) to other banks located overseas.
• An LoU is simply a request made to another bank in the SWIFT network to loan money to a client.
• The bank that issues the LoU essentially guarantees the bank that receives the LoU request that it stands by the creditworthiness of the borrower.
• PNB alleges that employees at one of its branches in Mumbai issued fraudulent LoUs that were not authorised by its management.

Why did it happen?

• PNB’s internal information systems were not seamlessly linked to SWIFT.
• It is claimed that the huge fund transfers made via SWIFT to Modi’s companies by a few PNB employees went undetected for many years.
• Many critics blame flaws in the ownership of public sector banks.
• The PNB scam came to light only after a whistle-blower exposed it.
• In PNB, the SWIFT system was not connected to Core Banking Solution (CBS).

Is this the first time?

• SWIFT has been gamed by miscreants on a number of occasions.
• In 2016, there was a cyber-heist of $81 million from Bangladesh’s central bank.
• Russia’s central bank recently reported that $6 million was stolen from a Russian bank last year by exploiting the SWIFT system.
• Even the Reserve Bank of India stated this week that it had privately warned Indian banks about the prospect of misuse of SWIFT at least three times since August 2016.

How the technology like blockchain can prevent frauds like PNB?

• The adoption of blockchain by India’s banks could help avert frauds such as the one at Punjab National Bank.
• The disaggregated and transparent nature of the technology, which updates information across all users simultaneously, would have ensured that various officials would have instantly been alerted to the creation of the letters of undertaking (LoUs)
• Transaction reconciliation systems at present do not result in immediate notification. Using blockchain, all parties on the chain will be immediately notified about a transaction
• Blockchain, a distributed ledger technology originally developed as an accounting system for the cryptocurrency Bitcoin, is being researched across the banking and financial services industries for the potential benefits it may offer in an increasingly digitised business environment
• Central banks including the U.S. Federal Reserve and the Reserve Bank of India have been examining the technology to understand the regulatory challenges it may pose.

Implications of the Blockchain technology:

Positive aspects:

• Blockchain potentially has far-reaching implications for the financial sector, and this is prompting more and more banks, insurers and other financial institutions to invest in research into potential applications of this technology.
• The RBI’s Working Group on FinTech and Digital Banking in a report highlighted that “Market participants in other securities markets are exploring the usage of blockchain or distributed database technology to provide various services such as clearing and settlement, trading.
• Blockchain utililty have potential to improve internal fraud monitoring.
• Blockchain would ensure easy tracking of entries.
• If the LoUs were on the blockhain, then they would have been there for everybody to see, and every entry into the chain leaves a clear record of who made that entry, and where.
• Blockchains are immutable and distributed ledgers, which means that anything recorded on them cannot be changed or deleted, and is instantly uploaded to all users on that blockchain.
• Through blockchain’s technology is such that even human error can be greatly mitigated. Blockchain can fix this by having everything linked to the same database.
• Blockchain helps in decentralized system where one need multiple branches to give their approval before any sort of transaction is approved or an LoU is issued.
• Another big challenge that blockchain can address is providing a basis for the trust banks have in each other, thereby preventing such frauds from taking place.

Negative aspects:

• In mature: Blockchain technologies aren’t mature yet. They are developing and evolving every day.  A lot of products that are being developed as a POC on a Blockchain aren’t even Blockchain secure.
• Lack of technical understanding: There is not much understanding of the Blockchain technologies and the advantages they provide over existing technologies.
• There are certain barriers which limit blockchain technology unusable for mainstream applications. They include
• Limited Scalability: Blockchains like Bitcoin, Ethereum have consensus mechanisms which require every participating node to verify transaction. This limits the total number of transactions a blockchain network can process.
• Privacy: In case of public Blockchains, transactions on blockchains might appear private since it is not directly tied to your identity.
• Access to external data: Blockchain services cannot inherently make arbitrary network requests to access data outside the network.
• Unavoidable security flaws: There is one notable security flaw in Bitcoin and other Blockchains, if more than half of the computers working as nodes to service the network tell a lie, the lie will become the truth.
• The number of transactions on the network is an existing limit which has caused a lot of heated debate recently.

Conclusion:

Blockchain is an ideal technology to ensure proof of integrity to the data and reduce incidents of fraud. This technology can be one way such frauds can be prevented.

Blockchain industry has proven itself robust and secure. But this doesn’t mean that there are not blockchain technology issues or problems that can affect the security of the entire ecosystem. That’s why you have to get a better knowledge and thus by to be well experienced in the tech area so that the material for blockchain to be surmountable.